Timing is everything for potential David Jones sale

The mutterings about whether a new crowd might come charging in with a healthy offer demanding the keys to DJs depends on a variety of factors.
Photo: Andrew Quilty

by
Simon Evans

Next month marks the 18th anniversary of the
David Jones
department store group becoming a separately listed entity on the Australian Securities Exchange. In the past few weeks there have been renewed rumblings about just how attractive DJs might be for an offshore suitor, and in particular whether the value of its property assets might form the basis of something meaningful for a potential private equity deal. Property might yet prove to be a potential jewel, because retail analysts are troubled by trends in the DJs core business, where profit margins are under pressure and there is a continued pattern of falling sales revenue.

The current custodians of the venerable department store chain kicked up their heels in May this year to celebrate DJs’s 175th birthday and it was at that function that chief executive
Paul Zahra
mentioned that David Jones was older than a host of global department store names including Harrods, Selfridges, Bloomingdale’s and Saks Fifth Avenue.

Just a few months on, there have been two sizeable transactions in the northern hemisphere where big retail chains have changed hands, one of them involving Saks Fifth Avenue.

The constant mutterings about whether a new crowd might come charging in with a healthy offer demanding the keys to DJs depends on a variety of factors. One of the most crucial is whether there is a real prospect that DJs might actually be able to reverse a sales decline that has occurred for each of the past three years since 2010. Cost-cutting can only take a business so far.

So while it has been almost 18 years since DJs was set free in a 1995 float with an issue price of $2 per share from the debt-plagued remnants of what was once a corporate powerhouse, the Adelaide Steamship Company, its status as a public company owned by institutions and mum and dad shareholders can never be guaranteed.

More than optimism needed

Timing is everything in business and in life. There are some hints of optimism from the various consumer confidence surveys around the country. Both DJs and its main rival
Myer
have been busy cutting into costs and re-positioning themselves to better compete in a market where householders are still focused on lifting their savings rates. Those householders are also more inclined to look at buying from overseas internet sites, armed with better purchasing power from a higher Australian dollar.

It was a long eight years under private equity ownership for Neiman Marcus, which operates at the luxury end of the retail sector and is headquartered in Dallas, Texas. Private equity owners TPG Capital and Warburg Pincus acquired the chain in 2005. But the usual time frame of between three to five years under private equity ownership had to be re-thought after the global financial crisis seriously disrupted the economy and the spending patterns of American shoppers.

The Neiman Marcus deal followed another big acquisition in the retailing sector in July, when Canadian department store chain Hudson’s Bay Co announced the purchase of New York-based Saks Inc, the parent of the Saks Fifth Avenue retail brand, for $US2.9 billion.

Some old hands point to these transactions as potentially being masterstrokes of timing, getting set ahead of an improving US economy where retail spending should in theory start rising.

With some prospect of an improving retail environment in Australia, in part fuelled by lower interest rates and in part by the wealth effect of rising house prices, whether DJs has the ability to increase sales revenue is occupying the minds of those in investment markets. The Christmas trading season, which is always a crucial component of any discretionary retailer’s financial year, looms as even more important this time around.

JPMorgan retail analyst Shaun Cousins says one of the main concerns at DJs is when sales might actually stabilise, with a “persistent reduction" in sales at the retailer a worry.

Shrinking revenue

DJs in 2009-10 generated total sales revenue of $2.053 billion for the 12 months ended July 31, 2010. That shrunk in 2010-11, and again in 2011-12. In the year just completed in 2012-13, it slipped again to a total of $1.845 billion. That’s $208 million of sales that have disappeared. While the company does talk about “quality" of sales as it exits less profitable sales, that’s a healthy chunk of revenue that has vanished. Where might those dollars have gone? Cousins suspects there has been some diversion of that spending away from buying goods to travel and eating out, some has gone to international specialty retailers that have entered Australia like Zara and Topshop, some to household savings, and some to international online retail competitors.

He suggests some sales “from the late 2000s have gone permanently".

JPMorgan expects that in 2013-14, DJs will have another year of negative like-for-like sales growth, which strips out the impact of store openings or closures. That will make it four in a row, with the last year of positive like-for-like sales growth happening in 2009-10.

Stockbroking house Citi points to the rise in the amount of space in DJs stores devoted to concession areas as being a factor in downward pressure on gross margins at the retail chain.

Those concession areas, where the department store sub-leases the space to a brand owner like Country Road or Sportscraft, deliver lower gross profit margins to DJs. The plus is that the concession deals remove any risk of getting stuck with racks full of shirts or pants that simply aren’t selling and prompt heavy discounting of the ticket price to get rid of them to a bargain hunter looking for some cheaper threads. But the negative is the lower margin. Woolford estimates the gross margin from concessions at DJs is 24 per cent, and this compares with 42.1 per cent in the other areas of the DJs store.

DJs’s gross margin of 38.3 per cent for 2012-13 was below the company’s own ambitious goal of between 39.5 per cent and 40 per cent.

Woolford attributes the failure to reach that target to the significant growth of concession sales. DJs added to the concession arrangements with a deal with electronics chain Dick Smith that officially started on Tuesday morning where Dick Smith will run the electronics departments of 29 DJs stores.

Investors need patience

DJs early in 2013 brought in outside expert CBRE to examine ways of extracting value from the Elizabeth and Market street stores in the bustling Sydney central business district. Woolford says investors will need patience. He values the airspace rights above the Market Street site at $100 million, but says DJs is unlikely to capture the development profit.

Citi says the Market Street store accounts for 6 per cent of DJs’s turnover, and is worth $116 million right now. He says any development is complicated because of the structural issues with the building and any value to be captured is likely to be at least three years away.

In the wash-up of last week’s full-year profit announcement by DJs, Credit Suisse, Citi, Goldman Sachs and JPMorgan all had either a sell, underweight or underperform recommendation on DJs, arguing the stock was too expensive. Target prices range between $2.37 to $2.60 per share. DJs shares closed up 4¢ to $2.93 on Tuesday afternoon, lending weight to those siding with the theory that some form of corporate activity may be possible. While people still chuckle over the $1.65 billion offer from the mysterious EB Private Equity in mid-2012 which turned out to be built on grand ideas and little else, the prospect of something more concrete from a credible firm remains a serious option.